“Doesn’t the bond market have to be a bubble? And yet because many investors, both sophisticated and unsophisticated, have been “winning” with bonds for decades (and “rational short sellers have been crushed”), most still don’t believe there is a bond bubble. Isn’t that the classic definition of a bubble? If the bond market isn’t a bubble, then the pre-crisis U.S. housing market (which in key markets, home prices have fully recovered or more, despite inflation being nil) wasn’t a bubble either…
…If the bond market is a bubble, doesn’t this put the lie to mortgage lenders causing the housing bubble? I think so. Why? Clearly, it is something else….government and central banks distorting markets and rates/money, investors investing “other peoples’ money”, etc. causing these asset bubbles/busts.”, Mike Perry, former Chairman and CEO, IndyMac Bank
July 6, 2016, Min Zeng, The Wall Street Journal
Are Treasurys Headed for 1%? New Lows in a 35-Year Downtrend
The yield on the benchmark 10-year U.S. Treasury note fell to its lowest level ever Tuesday
By Min Zeng
The yield on the benchmark 10-year U.S. Treasury note fell to its lowest level ever Tuesday, a new milestone in a three-decade downward run that even veteran traders never thought would go so far or last so long.
The yield closed below 1.4% for the first time at 1.367%, surpassing the previous record low set four years ago, according to data going back to 1977.
The question now is how low can they go. Investors buying Treasurys now are taking big risks, as prices of longer-term debt can move significantly if interest rates unexpectedly rise. But a generation of traders has been wrong in trying to call the top.
David Coard, now head of fixed-income trading in New York at Williams Capital Group, thought he had a handle on the direction of Treasurys when he bought his first house with his wife around the end of the 1980s. His mortgage rate was about 10%, and he told his wife mortgage rates, closely linked to Treasury yields, would probably never fall to 5%. Today, they are below 4%.
“It has been hard to fight this low-yield trend,” Mr. Coard said. “If you have been a bond bear, you have been on the wrong side.”
Tuesday’s move lower had familiar causes: Investors, worried about uncertainties facing markets and key economies after the U.K. voted to leave the European Union, moved into safer assets. Stocks and oil fell, as did the British pound.
Jae Yoon, chief investment officer at New York Life Investment Management, which had $286 billion of assets under management at the end of May, said the record leaves the 10-year in a precarious spot. Its yield could climb to 2% before the end of the year if the U.K. and European Union have “an amicable divorce,” work out trade issues and fears fade away.
On the other hand, he said, “if the global and U.S. [economies are] pulled down by Brexit, then yields have room to fall, and potentially we could see 10-year U.S. yields below 1%.”
Bond yields fall as prices rise—and the price of Treasurys has risen sharply. The Barclays U.S. Treasury Index has posted a total cumulative return of 1334.7% from the 10-year note yield’s peak near 16% on Sept. 30, 1981, through end of June.
The bout of falling yields since the start of 2014 has wrong-footed investors because it came even as the U.S. economy has recovered and as the Federal Reserve raised interest rates for the first time since 2006.
Yet few in the financial markets had foreseen negative interest rates in Europe and Japan—signaling investors are so desperate for safety that they are willing to buy bonds for more than they would get back at maturity.
Wednesday morning, the yield on Japan’s benchmark 20-year government bond fell below zero for the first time. The 10-year Japanese government bond yield also fell, hitting a record low of minus 0.275%.
The total of sovereign debt with negative yields jumped to $11.7 trillion as of June 27, up $1.3 trillion from the end of May, according to Fitch Ratings.
“At this juncture, I don’t think you can see anything but low interest rates in the U.S.,” said Gemma Wright-Casparius, senior portfolio manager of the fixed-income group at the Vanguard Group, which had more than $2.4 trillion in global assets under management at the end of March. “We continue to feel the gravity of the global bond markets. The bull run may still have a few years to run.”
U.S. bond yields soared during the 1970s and early 1980s as inflation rose in part because of surging oil prices. Paul Volcker, then the chairman of the Federal Reserve, raised the central bank’s key policy rate above 19% in June 1981. The 10-year Treasury yield hit a record three months later, then settled into its long dive.
“As long as the recent trend of low inflation, modest economic growth and reasonable wage pressures remain intact, the probability for an extended period of low interest seems sustainable,” said Bob Andres, managing partner at Andres Capital Management LLC, which has about $700 million in assets under management.
The consumer-price index rose 11% in September 1981 on an annual basis. This May, it was up 1%.
The bond market has been hit by a number of big selloffs over past decades. Among the biggest was the rout in 1994, when the Fed raised interest rates earlier and more aggressively than investors expected. That year, the Treasury index from Barclays posted a negative-3.4% total return.
The long bull market has been the backdrop for an entire career for John Mousseau, executive vice president and director of fixed income at Cumberland Advisors Inc., who started on Wall Street in 1980. Now, he is cutting his holdings of long-term Treasury debt to buy shorter-term securities, where the risk of big price moves is smaller.
“It has been a terrific ride [for] bond investors over the past decades,” he said. “But the risk of loss on your bondholdings is higher than before.”
Thomas Roth, executive director in the rates trading group at MUFG Securities Americas Inc., has been on Wall Street since the summer of 1984, when markets still worried about high inflation. Now, he says, the problem is stubbornly low inflation.
His youngest child will soon enter his final year of high school. Mr. Roth worries the economy may still be lackluster and yields still at these low levels when his son joins the labor force.
“We don’t know how low yields can fall, and we don’t know what the endgame is for the bond market,’’ Mr. Roth said. “It may end up badly. That is the scary part.”